Markets & Finance

Staying on the Sidelines

August 20, 2001

By Paul Cherney Long-term trends are created when long-term investors (read mutual funds, money managers) are convinced that the basic building blocks for a healthy economy and sustainable earnings growth are in place. That is not the condition today and the Fed's statement which accompanied the rate announcement made that perfectly clear.

I hear a lot of bullish market observers cite the "mountain of cash on the sidelines," but that mountain of cash in the money market mutual funds probably represents long-term investment cash and today's comments from the Fed did nothing to entice that money into the market.

There are two time horizons which govern market action: long-term inverstors and short-term traders. If the long term investors are not convinced that the economy is on sound footing, they will remain on the sidelines. Drops in prices will entice some longer-term investors to do some bargain hunting, but a disproportionate amount of the influence of prices will rest in the hands of the short-term traders, which increases the odds for some jagged non-trending price action.

If there is to be any sort of an intraday reversal and a little short-covering rally, then the market needs to plunge sometime on Wednesday (or Thursday) to entice short-term bears to take profits by buying to cover open short positions. Usually, this is an easy thing to spot in a non-summertime market. I just look for a drop in prices which sees volume surging (representing bears covering shorts, momentum players jumping in the bears' backs and some bargain hunters coming in off the sidelines).

But in today's market, the volume side of that equation might be hard to spot. Usually, I like to see 25% above the 50 day moving average of volume as a signal for a potential reversal point. For the NYSE that would be 1.4 billion shares of total trading volume for the day. For the NASDAQ that would be about 1.9 billion shares. I think these summertime markets would have trouble generating that kind of volume so picking a reversal point is more art than science in this August market.

The NASDAQ finished Tuesday's session in the 1853-1794 area of support. A short-covering rally is likely either Wednesday or Thursday, but the reversal may be difficult to recognize due the lack of volume. There is a focus of support 1838-1819. If prices move below 1794, the next level of support is 1760-1721.

Now that we have had a seventh rate cut, I looked back at NASDAQ price performance in the first year after a seventh rate cut (there have been four times since 1960). If the index recreated its worst performance in the wake of a seventh rate cut, it would close at 1651.28. The NASDAQ has immediate resistance 1862-1923 with a focus 1862-1881 then 1897-1916.

The S&P 500 has downside risk for prints in the 1151-1119 area, within this support band is a focus of support 1143-1128. Immediate resistance is now 1165-1170. Considerable resistance is 1174-1186.

Now that we have had a seventh rate cut, I looked back at S&P 500 price performance in the first year after a seventh rate

cut (there have been four times since 1960). If the index recreated its worst performance in the wake of a seventh rate cut, it would close at 1023.25 (very doubtful that the market gets to this level). Cherney is Market Analyst for Standard & Poor's